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Japanese Candlestick Sheds Little Light

This column was originally published on RealMoney on Oct. 18 at 1:32 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Japanese candlesticks are simple charts for trading that were popularized in the book Japanese Candlestick Charting Techniques by Steve Nison.

According to supposedly ancient Japanese techniques for commodity trading, they are usually very short, visual patterns that when seen in the markets are either bullish or bearish, depending on the mythology for that pattern.

I decided to test one of the more bullish patterns: the Morning Star. It's a three-day pattern that occurs when a stock has had a large down movement, followed by a gap down open but then a higher close, followed by a large up day.

In other words, you've hit bottom and reversed, and people are excited: Time to buy.

Below is an example of a Morning Star pattern in Amazon (AMZN - Get Report) in a chart covering eight days in early November 2002.

The idea is to buy at the close of the third day (indicated by the first arrow in the chart), the long up day.

The result in this example was a profit of 5.53% after buying at $19.34 and selling at $20.41 (as indicated by the second arrow).

I tested the Morning Star pattern on the current Nasdaq 100 stocks using data going back seven years, covering both bull and bear markets as well as flattish periods like the one we seem to be in right now.

There were 120 occurrences of the Morning Star pattern, and exactly 60 successes and 60 failures with an average return per trade (not including commissions and slippage) of 0.25%, which is not enough to beat commissions and slippage. (I held each position for one week, figuring that if this is a bullish sign, it should at least be bullish for a week.)


Charting the Morning Star
The pattern appeared in an early November 2002 chart of Amazon
Source: Wealth-Lab.com

If anyone has any favorite candlestick patterns they would like me to check out, please send them along.

Aficionados of Wealth-Lab or TradeStation can click here for the code I used for the simulation.

P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
It's always been my opinion that it pays to have more -- not fewer -- expert market views and analyses when you're making investing or trading decisions. That's why I recommend you take advantage of our free trial offer to TheStreet.com RealMoney premium Web site, where you'll get in-depth commentary and money-making strategies from over 50 Wall Street pros, including Jim Cramer. Take my advice -- try it now.
TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.

James Altucher is a managing partner at Formula Capital, an alternative asset management firm that runs several quantitative-based hedge funds as well as a fund of hedge funds. He is also the author of Trade Like a Hedge Fund and Trade Like Warren Buffett . At the time of publication, neither Altucher nor his fund had a position in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Altucher appreciates your feedback; click here to send him an email.

Interested in more writings from James Altucher? Check out his newsletter, TheStreet.com Internet Review. For more information, click here.

TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.

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